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ZTE and Building America’s Competitors

April 24, 2018

Last week’s draconian sanctions on Chinese telecom supplier ZTE follow a long-standing tradition in U.S. export controls: taking actions that help build the United States’ competitors and hurt U.S. companies.

To be clear, ZTE had violated the terms of its agreement and deserved to be punished. But the seven-year ban on U.S. components will only encourage foreign suppliers to rush into the space vacated by U.S. companies. It will reinforce the Chinese government’s desire to replace U.S. suppliers with Chinese companies. And it will lead others to begin to make things they did not make before, causing permanent harm to the market share of U.S. companies.

This is not the first time this kind of action has backfired. In the Clinton administration, the United States decided it did not want to sell satellites to China or satellite components to European companies that sold satellites to China. It declared that commercial satellites and their components were a munition, a weapon. This meant that any satellite that had a U.S. component, no matter how small, or any sale, no matter how harmless the customer (and most customers were NATO allies), required approval in the form of a license from the United States before export. A multimillion-dollar satellite with a $12 U.S. component now had to go through a cumbersome licensing process for export anywhere in the world. In the case of China, since the United States has a ban on arms sales to China, satellites from U.S. companies, whether made in Europe or the United States, were banned entirely for export.

European companies and governments did not take this change lightly. No other country regarded commercial satellites as a munition, nor did the United States try to persuade them otherwise or get the multilateral export control regime (the Wassenaar Arrangement) to treat satellites as weapons. The process of finding replacement suppliers began almost immediately.

The U.S. action did not block the development of China’s space program or prevent European satellite exports to China. The immediate effect was to encourage the Europeans to make components that they had previously bought from the United States, and within a few years European companies were advertising “ITAR-free” satellites (ITAR being International Traffic in Arms Regulations, the regulations that govern the export of munitions and that ban exports to China). An ITAR-free satellite could be sold without any need for U.S. approval. A few European governments even subsidized their companies to go into the satellite component business, creating permanent competitors for U.S. companies and damaging their market share without any benefit to U.S. security. An earlier episode involving machine tools, known as “Toshiba Konigsberg,” contributed to the demise to the U.S. machine tool industry, so that the United States ended up depending on foreign suppliers for this key industrial equipment.

In the 1960s, or even the 1970s, the United States could get away with this kind of blanket proscription. It made technology that no one else could duplicate. That is no longer true. The diffusion of technological capabilities around the work began more than 20 years ago, and the rate of diffusion continues to increase. Just this week, China’s president, Xi Jinping, called for China to redouble its efforts to close the gap with the United States in advanced technologies.

There are very few technologies where we still have a monopoly, and though it is in our national interest to prevent exports that improve China’s technological base, we should not delude ourselves that this will frustrate Chinese ambitions. At best it may slow them, but it will not prevent their efforts to close the gap. China may not retaliate directly or immediately, as it still needs some U.S. technology for mobile phones, but it will not allow ZTE to go under. Foreign suppliers will offer ZTE substitute goods if they make them and look to build substitutes if they do not.

The U.S. Commerce Department’s anger at ZTE’s violations is understandable and justified, and it fits with the narrative of the Trump administration’s trade and technology dispute with China. But the results of these actions can be counterintuitive. A more strategic course might have been to impose large, additional fines on ZTE without cutting off U.S. suppliers. Fines would punish ZTE and avoid the market distorting risks. U.S. technological leadership is diminishing as other countries become more adept at creating advanced technology, but our actions can affect and limit the pace and scope of this. The goal should not be to accelerate technological competition; ZTE’s punishment, however well deserved, may have the opposite effect.

James Andrew Lewis is a senior vice president at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).